It is well-documented that a significant portion of the historical equity returns are a result of reinvested dividends. In Triumph of the Optimists: 101 Years of Global Investment Returns (2002), the authors looked at equity returns from capital gains and dividends from 1900 to 2000. They determined that performance in any given year was driven by capital appreciation, but long-term returns were largely the result of reinvested dividends. Looking at 101 years of data in the U.S. and U.K., they found that a market-oriented portfolio with dividends reinvested would have generated nearly 85 times the wealth of the same portfolio relying solely on capital gains.

When most people hear the phrase dividend reinvestment, they will often associate it with dividend reinvestment plans (DRIPs). Many companies offer DRIPs through their transfer agent. Instead of sending dividend checks to shareholders enrolled in the company's DRIP, the company reinvests those dividends by purchasing additional shares (or fractional shares) in the shareholder's name. Most plans will reinvest a shareholder's dividends without a fee or commission. Some brokerages offer similar plans.

It is important to note that you can reinvest dividends without participating in a formal DRIP plan. Personally I have chosen not to participate in a formal DRIP plan. I prefer the flexibility of determining where my dividends are invested. I add them to my normal monthly investment, thus I do not incur any additional commissions.

Do you reinvest dividends through a formal program, independently or not at all?

Note: Be sure to read the comments for a lively discussion on how to invest dividends earned without incurring an additional commission.

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D4L, I'm not sure what you meant by the commission comment. I am like you though, I have a few DRIPS, but with the the majority of my dividends and distributions I just let them build up with my broker and use them to fund purchases that I would have otherwise made with saved money.

D4L: I do not participate in DRIPs. However, I do reinvest dividends through my brokerage account (no commission, fractrional shares possible, and have flexibility to change with few clicks). Flexibility helps rebalancing.

All: Sorry, I was not very clear in how I reinvest my dividends with no additional commissions.

First the operative word is "additional". Let's say hypothetically I invest $3,000/month and the dividends I earned during the month were $600. What I do is add the $600 to the $3,000 and invest it in where my asset allocation needs are. Thus I only spend $7 in commissions on the full $3,600, which is what I would have spent on the $3,000. Thus, no "additional" commission. The same would be true if I normally used the $3,000 to buy 3 different securities each month. Instead of investing $1,000 in each of the securities, I would invest $1,200 in each, again my commission is the same as it would have been without the dividends ($21 in this example). The only way I pay more commissions is if I independently invest the $600 in addition to what I normally would have done, thus increasing my commission by $7.00.

The above works for a taxable account that is funded each month. For my Roth IRA, I let the dividends accumulate to the minimum needed for an additional investment in a selected mutual fund, usually $50 to $100 for an IRA account. Once it reaches that level I invest in the mutual fund. Then once I add $1,100 to the mutual fund I withdraw $1,000 and purchase another income investment and start the process over.

Jason: I am not a tax person and I only have experience with a Roth IRA. In my Roth IRA domestic (U.S.) dividends are for the most part never taxed. There are some special rules for certain tax-advantaged dividends (REITs, MLPs, etc.) where they may be taxable at certain levels. But for "normal" dividends you receive from corporations, they are never taxed.

Can I just say thank you for writing "in the US" around some of your comments. I appreciate you can't do it all the time, or even more than some of the time - it'd get dull - but still it's really refreshing when a US blogger notes there is life beyond the US' shores. (I understand the US population dwarfs old England and so the temptation to just write for the US must be high).

UK dividend investors might want to Google "Barclays Capital Equity Gilt Study" to find similar research that proves the importance of dividends in the UK.

Anonymous
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September 15, 2009 at 12:33 PM

I have always had my DRIPS in my 401k that is exempt for tax. I also use an older standard IRA for a few DRIP stocks as well. I'm now embarking on whether I sell and pay tax now in order to "exempt taxes for life" by rolling it over into next year's beginning window for my ROTH IRA, especially since the tax to be paid will be spread over 2011 and 2012. To continue to exempt taxes on growth and dividends for the rest of my life is sure to mushroom into large gains.